Example Head & Shoulders Pattern in Crypto Trading
Named after its visual resemblance to the shape of a head and shoulders, this pattern has captured the attention of traders and investors alike. The head and shoulders pattern is a popular chart pattern used in technical analysis to predict potential trend reversals in financial markets, including the crypto market.
But how to identify and correctly interpret the head and shoulders pattern? Read below and find out based on a real example.
Example of Head and Shoulders Pattern in Bitcoin
The head and shoulders pattern is always bearish unless it’s inverted. When you invert the pattern, positioning the head at the bottom and the shoulders at the top, it can serve as a bullish indicator.
The moment you identify this formation on the daily chart, you can take it as the worst-case scenario for the specific asset or cryptocurrency you’re looking into. By delineating a head and shoulders trading pattern, you can brace yourself for an impending bear market.
Below, we’ll show an example of the head and shoulder pattern in Bitcoin.
The decrease in value and market cap in Bitcoin usually has a ripple effect on the crypto markets, creating a bearish sentiment altogether.
Bitcoin formed a head and shoulders pattern during the last two peaks, starting from the peak in August 2021 when it reached $51,875 to the peak in November 2021 when it reached $65,521.
These two peaks were followed by a second shoulder in December 2021, when it also fell at about the same level as in August, reaching 51,091.
The neckline was drawn by connecting the lows of the two shoulders, which were $58,786 on October 28 and $56,390 on November 19. The pattern was confirmed when the price broke below the neckline on November 20, signaling a bearish reversal.
A trader who spotted this pattern could have entered a short position when the price closed below the neckline, with a stop-loss above the right shoulder.
Yet, not every head and shoulders pattern works out perfectly. Sometimes, the price may fail to reach the target or even reverse back above the neckline. Therefore, it’s important to use other technical indicators and fundamental analysis to confirm the validity of the pattern and manage your risk accordingly.
Identify and Draw the Head and Shoulders Pattern
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The head and shoulders pattern can sometimes be hard to spot because it takes a long time to form during trending markets.
If the price action is sideways with little volatility, you can’t predict or draw the pattern.
Here’s how to draw it:
1) Go to Altrady trading terminal.
2) Select a market.
3) Select the Trend Tool. Click on the “Trend Line” tool highlighted at the top-left:
This tool allows you to draw directly over the chart by linking point A to point B.
4. Draw the pattern. You can start by drawing the first line that forms the left shoulder:
Continue drawing until you reach the head and connect the head to the second shoulder:
To complete the pattern, you connect the first shoulder to the second shoulder using the neckline:
This is the regular Head and Shoulders pattern.
The Trading Signal
Once you draw a neckline, you wait for the reversal to initiate.
Let’s say the lowest point on our neckline is $51,000 and Bitcoin peaked twice above that price point – with two new highs.
If the price of Bitcoin crashes from the lower-high down to $51,000, you can connect the two lines from the initial surge to the latest breakdown to $51,000.
Once the Bitcoin price crashes below $51,000 (the neckline) – this is a trade signal to short Bitcoin expecting further depreciation.
The neckline provides the confirmation signal. If you see a downward slope and this shows bearish activity, the trend is more reliable.
Trading Psychology – The Head & Shoulders Pattern in Crypto Markets
What is the psychology behind this pattern? Why does it form and what does it mean for the market sentiment?
The head and shoulders pattern reflects a shift in the balance of power between buyers and sellers. The buyers are losing confidence and enthusiasm, while the sellers are gaining strength and conviction.
During the formation of the first peak (left shoulder), market participants may still be optimistic about the asset's price, driving it higher. As the price reaches its peak, profit-taking and increased selling pressure start to emerge.
The subsequent decline indicates a profit-taking by some buyers, as well as some selling pressure from the bears.
The second peak (the head) represents buyers’ renewed attempt to resume the uptrend, but they fail to sustain it, as the price reaches a higher high but quickly reverses. This shows that the buyers are facing strong resistance from the sellers, who are becoming more aggressive and confident.
The third peak (the right shoulder) represents buyers’ final attempt to push the price higher, but they fail to reach the previous high. This means that the buyers are exhausted and losing interest, while the sellers are ready to take control. It confirms the bearish sentiment.
The neckline represents a support level that keeps the price from falling further. However, once the price breaks below it, it confirms that the trend has reversed and that a downtrend has begun. The neckline then acts as a resistance level that prevents the price from rising back.
The head and shoulders pattern can be seen as a reflection of human emotions and behavior in the market. It shows how greed, fear, hope, and despair can affect price movements and create patterns that can be used to anticipate future trends.
The head and shoulders pattern is a valuable addition to the toolkit of any crypto trader. It can help identify potential trend reversals and guide your trading decisions. Additionally, understanding human behavior is key to unlocking the secrets of these patterns.
However, knowing how to interpret this pattern alone doesn’t guarantee success in the volatile world of cryptocurrency. Always use it in combination with other technical indicators, conduct thorough research, and practice risk management.